Some investors today are doing what worried investors always seem to do in times of stress—trying to avoid “risk” by buying the “safest” assets. In this case that has meant buying government bonds from the United States, Germany, Australia, the Netherlands, and other countries considered safe havens.
Panic buying has pushed yields in some cases to negative levels, meaning investors are willing to pay a small amount of money in order to park their money in a government bond. Is this rational? Probably not—investors seem to be guaranteeing themselves a negative real return after inflation. The only way to make money on such an investment would be to live through a depression with accompanying massive deflation.
Investors are also ignoring the market’s mechanisms for dealing with risk. All the risks that investors are worried about today—financial troubles in Europe, slowing economies in the United States and China—are already priced into the market. Investors have pushed down prices of volatile investments such as stocks and commodities, and at the same time have pushed down yields on less-volatile government bonds.
What does that mean? It means that the risk premium investors now demand for putting money into a risky asset has gone up. Investors are pricing stocks, for instance, at a price that expects higher returns sometime in the future, says Jim Parker, a vice president of Dimensional Fund Advisors, a Santa Monica, CA-based investment firm. If the market’s risk appetite revives in the future, owners of risky assets will be paid “a very substantial return,” Davis writes. “The takeaway is that sheltering in what are perceived as the safest government bonds may provide certainty for a time, but also comes at the cost of foregoing the significant increase in risk premiums that may be available,” he writes. He notes that yields approached zero back in early 2009 after a brutal bear market, but just before world stock markets staged a sharp recovery. Investors who had bought government bonds at that time may have felt ok for a while but they gave up a stretch of gains that reached nearly 100 percent over the next few years.
